H2 Prelims Paper 2 Q2 Suggested Answers

2. Evidence has shown that the workers’ participation rate for skills upgrading workshops is generally low, mainly due to ‘short-sightedness’ by both firms and employees. Firms are worried that trained workers quit to join the competitors. Training subsidies provided are also unevenly distributed to different industries. (a) Explain how the market for skills training may fail. [10] (b) Discuss the view that government intervention in the skills training market may create more problems than it solves. [15] Suggested Responses (a) Explain how the market for skills training may fail. [10] Question analysis Command Word “Explain” – requires student to explain how the market for skills training allocate resources inefficiently – positive externalities and imperfect information Context Skills Training Concept Market failure – positive externalities, imperfect information Introduction: Consumers behaviour in the demand for skills training, is influenced by their objective of maximising self-interests (satisfaction). With upgrading of skills, there are possibilities of earning higher income, better promotion prospects in their career. From the perspective of employers, they are influenced by their objective of maximising their profits. When employees skills increase, there are possibilities of a higher productivity and higher profits. Body paragraph/Requirement 1: The market for skills training may fail due to positive externalities Explaining the market equilibrium (maximising self-interest): In maximising their satisfaction, consumers only consider their marginal private costs (MPC) and marginal private benefits (MPB). In this case, • MPC = payment for skills training courses and opportunity costs incurred e.g. loss of income during the period of skills training.

• MPB = higher income that could be earned upon completion of these skills training programmes Thus, consumers, based on their own benefits and costs, will decide to consume at the market equilibrium level QM, where they equate their MPC to MPB, at the equilibrium price Pm. They totally ignore the benefits to the third party. Explaining the benefits to third parties (divergence between MSB and MPB): The full extent of benefits include benefits to individuals and third parties i.e. firms and economy. Benefits to third parties are termed external benefits. Some examples include: • Firms benefit from the rise in labour productivity as workers complete their skills training to undertake improved production techniques. These firms, with a more skilful workers, could adopt technology / automation in their production processes, enabling firms to become more efficient and earn higher profit margin. • (In addition, Countries with higher productive labour force would also attract overseas investment which would lead to job creation leading to higher economic growth in the country) • The full extent of benefits is measured by MSB which includes both MPB & MEB. Explaining the market failure: To society, the socially optimal level of consumption of skills training would be where society welfare is maximised. Thus, consumption should be at QS where MSC = MSB. For every unit of skills training consumed by worker from QM to QS, MSB > MSC. Hence there is a net potential welfare gain by society with additional consumption QmQs. For every unit consumed beyond Qm, society benefits from the potential welfare gain (area B Es Em). Thus, when consumers are left to pursue only their self-interest, there will be under-consumption QMQS,, resulting in inefficient allocation of resources in the market for skills training. Body paragraph/Requirement 2: The market for skills training may fail due to imperfect information Qty Benefits Costs MSC = MPC MSB MPB Ps Pm Qs Qm O Em Es Market for skills training B

Due to imperfect information, consumers’ perceived benefits from ski lls training may be lower than their actual benefits. Consumers may not have the knowledge of how the new / upgraded skills acquired through training (formal or informal) would enable them to have better career progression leading to higher future income. They may only perceive the short-term benefits e.g. how information technology coding courses or management courses would lead to a rise in their current salary. Their actual benefits would include rise in their occupational mobility, employability or even career advancement, promotion to managerial positions with even much higher future income. Their actual benefits of such skills training would thus be much higher than the perceived benefits. Hence when left to pursue their self -interests, workers, will consume at Q m where MPBperceived=MPCperceived. However, the satisfaction would have been maximized at MPBactual=MPCactual at Qs. There is an underconsumption of Qs -Qm, resulting in an efficient allocation of resources in the market for skills training. As they would have benefited more than it costs them every unit from Qm to Qs, a welfare loss of BEsEM. OR Body paragraph/Requirement 2: The market for skills training may fail due to moral hazard The market for skills training may also fail due to moral hazard. Moral hazard is the situation in which asymmetric information results in economic agents taking greater risks than they normally would because the resulting costs will not be borne by them. In the case of skills training, the employer may not know the actions of the worker during and after training. Unless the employer can observe the w orkers’ progress during the training and worker is bound by a contract, the employer might not know if the worker would skive during training or change the company he/she works at upon completion of training. This is detrimental to the employer’s profits. There is a wastage of resources and firms may also be less incentivized to send their workers for skills training, leading to an inefficient allocation of resources. B Qty Benefits Costs MPCperceived = actual MPBactual MPBperceived Ps Pm Qs Qm O Em Es Market for skills training

Knowledge, Application, Understanding, Analysis L3 ▪ Accurate and clear analysis of two types of market failure o Positive externalities o Imperfect information (either inaccurate information or moral hazard) o ▪ Answer provides relevant examples of market for skills training 8 – 10 L2 ▪ Undeveloped or some inaccuracies when explaining market failure due to o Positive externalities o Imperfect information (either inaccurate information or moral hazard) Or ▪ Answer only explains one of the above requirements ▪ Answer provides some examples of market for skills training 5 - 7 L1 ▪ Inaccurate and minimal analysis or descriptive answer ▪ Answer is largely irrelevant 1 – 4 (b) Discuss the view that government intervention in the skills training market may create more problems than it solves. [15] Question analysis Command Word “Discuss” – requires student to analyse the problems that may be created when government intervene in the skills training market and evaluate the extent to which this is likely Context Market for skills training Concept Government intervention – government failure, unintended consequences of government intervention Introduction: Governments aim to maximize society’s welfare. Given that the market for skills training fails due to positive externalities and imperfect information, the government has to intervene in order to bring the market to the social equilibrium level. However, due to government failure, this may result in problems and unintended consequences in the market. Body paragraph/Requirement 1: Government intervention may result in inefficient allocation of resources due to inaccurate information on amount to subsidize

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